Oct 18, 2012
Executives
Shirley Stacy - VP, Corporate and Investor Communications Tom Prescott - President and CEO Ken Arola - VP and CFO
Analysts
Matt Dolan - Roth Capital Partners Glen Santangelo - Credit Suisse Brandon Couillard - Jefferies & Company Steve Beuchaw - Morgan Stanley Jeremy Feffer - Cantor Fitzgerald John Kreger - William Blair
Operator
Welcome to the Align Technology Q3 2012 Earnings Call. At this time all participants are in a listen-only mode.
A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce, Shirley Stacy of Align Technology. Ms.
Stacy, you may begin.
Shirley Stacy
Good afternoon and thank you for joining us. I'm Shirley Stacy, Vice President of Corporate and Investor Communications.
Joining me today is Tom Prescott, President and CEO; and Ken Arola, Vice President and CFO. We issued preliminary third quarter financial results press release today on Marketwire, which is available on our website at investor.aligntech.com.
Today's conference call is being audio webcast and will be archived on our website for approximately 12 months. A telephone replay will be available today by approximately 5.30 pm Eastern Time through 5.30 pm Eastern Time on October 25.
To access the telephone replay, domestic callers should dial 877-660-6853 with conference number 400990 followed by pound. International callers should dial 201-612-7415 with the same conference number.
As a reminder, the information that the presenters discuss today will include forward-looking statements, including without limitation statements about Align's future product, product outlook and the expected financial results for the fourth quarter of fiscal year 2012. These forward-looking statements are only predictions and involve risks and uncertainties such that actual results may vary significantly.
These and other results are set forth in more detail in our Form 10-K for the fiscal year ended December 31, 2011. These forward-looking statements reflect beliefs, estimates and predictions as of today and Align expressly assumes no obligation to update any such forward-looking statements.
Please also note that on this conference call we will provide listeners with several financial metrics determined on a non-GAAP basis for comparisons to previous quarters. Most of these items, together with the corresponding GAAP numbers and the reconciliations to the comparable GAAP financial measures, where practical, are contained in today's financial results press release, which we have posted on our website at investor.aligntech.com under financial releases, and have been furnished to the SEC on Form 8-K.
We encourage listeners to review these items. In addition the possibility of an impairment charge which could result in a substantial reduction against goodwill and a commensurate charge against earnings could have a material adverse impact on the company’s preliminary results.
We have posted a set of GAAP and non-GAAP historical financial statements, including the corresponding reconciliations and our third quarter conference call slides on our website at investor.aligntech.com under quarterly results. Please refer to these files for more detailed information.
With that, I'd like to turn the call over to Align Techology’s President and CEO, Tom Prescott. Tom?
Tom Prescott
Thanks Shirley. Good afternoon everyone.
On the call today, I’ll provide an overview of preliminary third quarter results and discuss the performance of our two operating segments Invisalign clear aligners and scanner and CAD/CAM services. As Shirley discussed these results are preliminary based on the outcomes of our goodwill impairment analysis which is currently incomplete.
Ken will cover these circumstances and a discussion of our preliminary Q3 financial results as well as outlook for Q4 in more detail. I’ll come back with a few closing comment and open up the call to questions.
Q3 revenue of 136.5 million increased 8.4% year-over-year and yet decreased 6.3% sequentially. Despite a strong summer season for Invisalign teenager cases, which increased 21% sequentially and year-over-year, our third quarter revenue was slightly lower than our outlook.
Q3 is historically a slower period for North American GP dentists who have fewer days in office due to vacations as well as for International doctors who typically take extended summer holidays, especially in southern Europe. This year summer seasonality was more pronounced in North America and as a result, we did not see the expected ramp in Invisalign cases for GPs and Orthodontists.
This softness has continued through October and is reflected in our Q4 guidance, which despite that slowdown, still projects a healthy annual growth rate for the company overall, with volume growth of at least 16%. We’re taking a complete look at our results, including demand for our products and analyzing the industry and the markets in which we operate.
We are evaluating a lot of data, much of which is conflicting, and none of which supports a fundamental decrease in demand for Invisalign. On the one hand, data such as the surprisingly strong, recent consumer sentiment ratings, as well as the uptick in visitors to Invisalign.com, and Find A Doctor searches point to continued strong consumer interest.
On the other hand, additional insight from our customers regarding Invisalign in their practices indicate that more adult patients were delaying or pushing out acceptance of their ClinCheck treatment plans this summer and early fall, possibly due to concerns about the economy. Several recent analyst reports based on AFG Research suggest that conditions within the dental space during the calendar third quarter were slightly less desirable than in the second quarter and AFG reports developed for Align corroborates these trends.
Several weeks ago in an analyst meeting Patterson Dental discussed the slowdown for dental consumables. Beyond all of the survey work done, there remains a dichotomy between the tougher economic realities for the broader economy and the actual case starts we had in Q3, when compared to the optimistic views on Invisalign sounded by both consumers and doctors.
For Q3 total Invisalign case volume was 92,500 an increase of 17% year-over-year driven by growth across all customer channels. This was especially the case for North American orthodontist and international doctors which both increased about 20% from the same quarter last year.
On a sequential basis, Q3 Invisalign case volume decreased 3% primarily due to North American GPs which declined 7%. For North America orthodontists Q3 case volume of 35,900 cases increased 19% year-over-year driven primarily from growth across nearly all Invisalign products especially Invisalign Teen.
Q3 volume increased 1% from Q2 reflecting lower Invisalign Full cases offset by the growth from Invisalign Teen cases which increased 34% sequentially among North American Orthos. The Invisalign Teen product is primarily targeted at younger teens 11 to 15 years old and has specific features such as compliance indicators and (inaudible) to address the needs of these younger patients.
For Q3 total Invisalign Teen case shipments were 15,300 cases worldwide an increase of 30% year-over-year and 29% sequentially a positive indication of continued progress. As expected, both Orthos and some GPs took advantage of the Invisalign Teen/Vivera Retainer promotion we ran this quarter in North America, which includes a free Vivera Retainer subscription for every Invisalign Teen case a customer buys.
Just as a reminder the objective of this promotion is to drive penetration Invisalign in the teenage orthodontic segment during the summer season and generate broader trial and use of Vivera Retainer. During Q3 last year, when we first offered the Teen/Vivera promotion we saw a strong uptick in Invisalign Teen cases and this year we saw a similar uptick.
Over the past 12 months, the doctors who participated in the promotion have subsequently grown their Invisalign Teen and Vivera case volume faster than doctors who did not participate. In addition to reporting our results for the Invisalign Teen product we also tracked the total number of teenagers using any Invisalign product which is a more complete view of our penetration in this very important segment of the orthodontic market.
During Q3 a total of 24,500 teenager worldwide started treating with Invisalign, this is an increase of 21% sequentially and year-over-year and demonstrates our continued progress and share gain among teen to 11 and 19 years old worldwide. For North American GP dentist Q3 case volume of 34,700 cases increased 12% year-over-year driven by growth across all Invisalign especially Invisalign Express.
On a sequential basis, Q3 GP volume decreased 7% from Q2 due to lower Invisalign Full and Assist cases. We believe softness in higher end adult procedures like full mouth restorations, veneers, and Invisalign may have played a part.
For our customers outside of North America, Invisalign volume of 21,900 increased 21% year-over-year the fourth consecutive quarter of 20% plus year-over-year growth for international. This growth was driven primarily by an increase from Invisalign distributors, especially the Asia-Pacific region, as well as from nearly all European countries that we covered directly.
As expected, Invisalign case volume outside North America was down slightly around 3% sequentially, reflecting summer seasonality primarily in southern Europe. In our direct geographies Q3 year-over-year growth in core Europe was led by the UK and CEU comprised of Germany, Switzerland and Austria.
Italy volumes were down compared to last year and while the signs of economic distress and austerity measures are obvious, we also had an execution miss. We have new country leadership in place and expect to find our way back to a growth posture much like what we did in the U.K.
two years ago. And in Asia, Q3 Invisalign case starts in China continued to ramp while Japan continues on its growth track.
We see strong business growth in China, which we believe is being driven by our strategy of working with Key Opinion Leaders, going deep with top orthodontists in core cities. We had a strong presence at the annual Chinese Orthodontic Meeting held at Peking University in September where we saw the first wave of Chinese KOLs our orthodontist’s customers speaking about Invisalign in a scientific sessions presenting Invisalign, the technology, finished and cases in progress.
This represents a major step forward as we now have domestic, in-country Chinese KOLs carrying the message, promoting Invisalign. We will continue to execute on our core strategy, which is working; combined with ongoing tests to best understand the local levers of accelerating volume here in China.
We remain very bullish on the long-term potential for this country. In Q4 we will expand our focus on clinical education we will be hosting over 20 leading Chinese doctors at the North Asia Invisalign form in Macau which will bring the other top clinicians worldwide to discuss treatment of very complex cases.
And in November a handful of Chinese doctors will also attend our Ortho Summit in Las Vegas. Q3 was another great quarter for our Invisalign distribution partners in the APAC, EMEA, and Latin America regions.
Year-over-year as well as sequential growth was driven by continued strength in the APAC region, especially Australia and Hong Kong. As a result of our continued success in the APAC region and with the upcoming expiration of the distribution agreement with our partner there, we have decided to revert Asia Pacific into a direct sales region beginning May 1, 2013.
We will be taking back the APAC organization as well as its entire team and operating expense structure. We will step up investments in the form of increased OPEX during the fourth and first quarters in order to ensure a seamless transition for our customers.
In the near-term, this increased operating expense committed towards continued APAC growth and organizational continuity will create a little more operating margin pressure. After May 1st next year, we will begin to recognize direct sales at our full ASP, rather than the significantly discounted ASP under the distribution agreement, and will thereby quickly gain revenue and contribution margin leverage.
The overall economic costs of this reversion have less than a one year payback for us. On a year-over-year basis, we saw continued adoption across our customer base in Q3 led primarily by North American doctors which is reflected in our key Invisalign metrics of utilization and new customer training.
The year-over-year Ortho volume growth was driven by both an increase in Invisalign utilization as well as an increase in the number of new Ortho submitters. The year-over-year, GP volume growth is driven primarily by an increase in newly trained GP submitters.
Sequentially, Q3 utilization rates remain flat among North American Orthos and international doctors while North American GPs actually decreased due to lower case volumes and fewer submitters. Among our North American GP base, we saw a decrease in Invisalign case starts across all customer tiers in particular our mid to high volume GPs.
As expected we trained fewer doctors in Q3 as we typically hold fewer CE1 training events during the summer timeframe. Moving onto product innovation.
I’m excited to be talking about one of the most important innovations in Invisalign Orthodontics our SmartTrack aligner material. Over the past five years working with world class partners, we have evaluated literally thousands of polymers and a variety of other materials.
And our goal was to optimize conformance and comfort for the patient with the ability to consistently deliver planned forces over an extended period of time and to ensure greater predictability for even a most complex cases. Today we introduced a remarkable material for the world of clear aligner treatment we call SmartTrack.
SmartTrack is a novel highly elastic new aligner material that delivers general, more constant force to improve the control of tooth movements with Invisalign clear aligner treatment. SmartTrack represents not just an improving in aligner material, it's a significant improvement in Invisalign system and how we leverage forced systems for more predictable tooth movement.
We have specifically engineered a flexible material to more precisely conforms to tooth morphology, attachments and interproximal spaces to improve control of tooth movement across treatment. We initiated a large scale pilot with over thousand customers in May and the analysis of patients treated with aligners shows statistically significant improvement in control of tooth movements, especially for the most difficult such as rotations and extrusions.
According to Dr. Clark Colville, an orthodontist in Seguin, Texas and member of our Clinical Advisory Board, “The clinical results with SmartTrack have been excellent so far.
The fit around the teeth from aligner to aligner is better than with any group of patients I have previously treated with Invisalign in my practice. Without a doubt, SmartTrack is the most exciting change in Invisalign technology among the many that have been introduced in recent years.”
And for Dr. Werner Schupp, an orthodontist practicing in Köln, Germany said, “I’m very pleased with the new SmartTrack aligner material.
The aligners fit better and are much more comfortable for our patients, and the tooth movement is more precise in all directions.” The feedback to-date from our pilot doctors has been very positive and we can’t wait for all of our customers and our patients to experience these revolutionary changes themselves.
In Q1, 2013, SmartTrack will become the standard Invisalign aligner material for Invisalign clear aligners in North America and Europe as well as in other international markets where regulatory approval has been obtained. In the meantime we have begun previewing SmartTrack material on our customer portal aligntechinstitute.com.
In addition, we will showcase SmartTrack at our upcoming Ortho Summit in November and in January we will host the extra webinar in advance of the worldwide launch of SmartTrack. As per our integrated consumer marketing platform, activity in our consumer website is a good measure of progress in this front where a perspective patients can get more information taken interactive smile assessment based on their own goals for treatment and search for Invisalign providers in their area.
During Q3, we passed a big milestone and ended the quarter with more than 4.2 million visitors to Invisalign.com to date this year, a nice increase from the same period in 2011. In addition, web site leads are up and Find a Doctor searches are up from the same time last year We also continue to see increasing traffic from mobile device users, with visitors to the Invisalign.com mobile site, now making up around a quarter of our total traffic when our ads are on TV.
All of these metrics tell us that prospective patients remain interested in learning more about Invisalign and for connecting with providers in their local area when they are ready to seriously continue treatment. Website traffic like many of our consumer metrics is positively influenced by our on-air TV presence.
In early Q3 we continued leveraging the peak “teen season” by running our “Twins” TV spots to reach moms and teens. This year we were off air for three weeks in July to avoid competition with the Olympics.
However, we supplemented our TV presence during those important final summer months with radio, digital, and traditional PR and event marketing, including our second year sponsoring Radio Disney’s Next Big Thing Tour, which includes elements of all of those marketing channels, including a lot of Disney radio and TV placements. Moving now to our scanner and CAD/CAM services segment, Q3 revenue was 9.8 million compared to 11.9 million in Q2 and 11.6 million in Q3 last year and it reflects summer seasonality.
In addition, there were no major industry or Invisalign customer events that would give us additional selling opportunities like the AAO meeting in May 2012 and the GP Summit in July 2011. These major tradeshows and customer events like Invisalign Summits provide a unique opportunity to present iTero scanners and close orders.
The announcement we made regarding our Straumann distribution agreement (inaudible). Since acquiring Cadent 18 months ago, we have been committed to enabling a digital shift within restorative dentistry, with the iTero scanner as the center of our strategy.
We have worked with Straumann over the past few years to establish a sales, services, and support model for the iTero scanner that would benefit both our companies. The global market for restorative dentistry is far more fragmented and complex than orthodontics with hundreds of thousands of labs, suppliers, general dentists, and specialists.
In Europe, adoption of digital restorative technology has been further slowed due to challenging economic conditions and reluctance to invest in capital equipment. Despite our efforts, our collaboration for distributing iTero scanners is not meeting our strategic or financial expectations.
As a result, Align has decided to market iTero on a more limited basis directly in Europe focusing on our existing Invisalign customers and pursue global scanner potential on a more opportunistic basis. We will continue our direct sales of iTero scanners in North America where digital dentistry is evolving more rapidly.
Over the past year, we’ve invested in our scanner business in North America by doubling the number of direct sales representatives and in-office trainers, through ongoing improvements in scanner service and support, and through a robust product and applications development pipeline. We’ve demonstrated this business model can work and we are confident we have the best performing scanner in the market.
Both Align and Straumann are committed to ensuring a continued high level of service and support for our existing iTero customers in Europe and North America. Straumann will continue to offer first-level equipment support in Europe for at least the next 12 months, after which full responsibility for regional customer service will transfer to Align.
We are currently working together on plans for a smooth transition and will communicate details to customers as soon as they are finalized. I will now turn the call over to Ken for a review of our Q3 financial results.
Ken.
Ken Arola
Thanks Tom. Before we get in the preliminary results for the quarter, I will begin by discussing the status of our goodwill impairment testing.
The discontinuation of Align’s distribution relationship with Straumann in Europe and North America and the decline in results of operations of the Company’s Scanner and CAD/CAM Services reporting unit triggered the risk that the goodwill associated with the acquisition of Cadent might be impaired. As a result, we are currently conducting a step one test as of September 30, 2012, to assess whether goodwill, which had a carrying value of $135.3 million as of September 30, 2012, is impaired.
We expect to complete the step one impairment test prior to filing our Form 10-Q for the third quarter of 2012. If the results of our step one analysis indicates an impairment, we will conduct a step two evaluation to determine the amount of the non-cash impairment charge, if any.
If step two cannot be completed prior to filing our Form 10-Q for the third quarter, we may estimate a range of potential impairment and may record an estimated non-cash charge in the third quarter of 2012. Any difference between an estimate and the final step two evaluation would be recorded in the fourth quarter 2012.
Any difference between an estimate and the final step to evaluation will be recorded in the fourth quarter of 2012. Before I move on to the third quarter financial results, I like to remind everybody that there are several items we exclude from a GAAP results when we report non-GAAP results.
These include acquisition and integration related cost, amortization of intangible assets, and severance and benefits cost for the New Jersey consolidations. In my comments today, I will not review the total dollars excluded for non-GAAP gross margin, operating expenses and operating margin and instead we will refer to the press release tables reconciliation of GAAP to non-GAAP financial metrics and the business outlook summary for a complete reconciliation.
Now let’s review our preliminary third quarter financial results which do not include the impact of any potential goodwill impairment. Q3 net revenue was a total of $136.5 million which consisted of Invisalign revenue of 126.7 million and scanners and CAD/CAM services revenue of 9.8 million.
This is a sequential decrease of 6.3% from 145.6 million in quarter two 2012 and a year-over-year increase of 8.4% from 125.9 million in Q3 2011. Q3 Invisalign revenue of 126.7 million decreased 5.2% compared to Q2 revenue of 133.7 million and increased 10.9% compares to Q3 2011 revenue of 114.3 million.
The sequential decrease in Q3 revenue was driven by lower case volume primarily across our North America GP and international doctors as well as some slightly lower Invisalign ASPs. Invisalign ASPs were lower as expected compared to last quarter due to deferrals associated with the Invisalign Teen Vivera Retainer promotion and headwinds from foreign exchange rates.
On the year-over-year basis, Q3 Invisalign revenue growth was driven by volume increases offset somewhat by foreign exchange rates. Q3 scanner and CAD/CAM services revenue was $9.8 million which is a sequential decrease of 18.3% from 11.9 million in Q2 2012 and a year-over-year decrease of 15.9% from 11.6 million in Q3 2011.
The scanner volumes were down as expected as there were no major industry or company sponsored (inaudible) in which to leverage scanner selling opportunities as compared to Q2 where we have the AAO show and several customer forums. Q3 CAD/CAM services were flat in North America as compared to the prior quarter and international (inaudible).
Now moving onto gross margin and operating expenses. Q3 GAAP gross margin was $100.4 million or 73.5% this compares to 108.8 million or 74.7% in quarter two and 92.4 million or 73.4% from the same quarter last year.
Q3 GAAP gross margin for Invisalign was 77.6% and scanner and CAD/CAM services was 20.6%. This compares to 79% and 26.6% respectively in quarter two.
Non-GAAP gross margin for Q3 was 100.7 million or 73.7%, and this compares to 109.2 million or 75% in quarter two and 93 million or 73.9% in the same quarter last year. For Invisalign there was no difference between GAAP and non-GAAP gross margin for Q3 or Q2 of 2012 and Q3 of 2011.
The sequential decrease in non-GAAP gross margin primarily reflects lower Invisalign case volume which result in under absorption of manufacturing cost and the impact from lower ASPs. For scanner and CAD/CAM services, Q3 non-GAAP gross margin was 23.8% compared to 30.3% last quarter.
The decrease in non-GAAP gross margin reflects lower production volumes instead of under absorption of manufacturing spend coupled with excess training capacities during the seasonally slower summer quarter. Q3 GAAP operating expense was 71.2 million compared to Q2 of 72.8 million and 66.1 million from the same quarter of last year.
Q3 non-GAAP operating expense was 70 million and this compares to 71.6 million in quarter two and 53.8 million in the same quarter of last year. The decrease in Q3 non-GAAP operating expense in primarily due to lower media spending as we went out there during the Olympics as well as fewer industry and customer events being held in quarter three.
Q3 GAAP operating income was 29.2 million or 21.4%, this compares to 36 million or 24.7% in quarter two and 26 million or 20.9% in the same quarter a year ago. Q3 non-GAAP operating income was 30.6 million or 22.4%, this compares to 37.6 million or 25.8% in quarter two and 29.2 million or 23.2% in the same quarter of last year.
Q3 GAAP diluted earnings per share was $0.29 compared to $0.34 in quarter two and $0.24 in the same quarter of last year. And Q3 non-GAAP diluted earnings per share was $0.28 compares to $0.34 in quarter two and $0.27 in Q3 of last year.
Now moving onto the balance sheet. Cash, cash equivalents and marketable securities including long-term investments were $348.9 million, this compares to 248.1 million at the end of 2011.
In Q3, we generated roughly 40.3 million in cash from operations compares to 27.3 million in quarter two and 41.5 million in the same quarter of last year. DSO for the quarter was 70 days compared to 63 days in quarter two and 62 days in the same quarter last year.
The increase in DSO this quarter primarily reflect less shipment linearity in the quarter and a slightly slowing of customer payments in September. Overall, our aging remains in solid shape and I’d expect DSO to trend downward in Q4.
Under our stock repurchase program, we bought approximately 213,000 shares of our common stock in Q3 at an average price of $34.15 per share for a total of approximately 7.3 million. There remains 132.5 million available under the company’s existing stock repurchase authorization.
Now let’s turn to our business outlook for Q4 2012 and the factors that inform our view. First, we experienced greater than expected summer seasonality in North America, from both GP dentists and Orthodontists.
This softness has persisted into October which resulted in lower case receipts from which Q4 shipments are generated. However, busy sales force activity and patient traffic in October points to renewed growth for the Invisalign business.
Second, Q4 is historically a stronger quarter for international doctors as they come back from summer vacations and we would expect that to be the case this year as well. Third, Q4 is historically the heaviest buying period for capital equipment purchasers in North America.
In order to make the most of this year-end buying cycle, we are offering a promotion of $4,000 off an iTero scanner in Q4. There are also two major events we will be leveraging in Q4, the ADA meeting going on in San Francisco this week and our Invisalign Ortho Summit in November.
As a result of these sales and promotional activities, we expect North American scanner sales to increase nicely from Q3. For International, we do not expect any contribution due to the termination of the iTero distribution agreements with Straumann announced today.
And lastly, given the slowdown we have seen recently, we are more cautious about consumer behavior in the near term and their willingness to move forward with higher value procedures like Invisalign. With that as a backdrop, we anticipate Invisalign case volume to be in a range of 90 to 93,000 cases.
We expect Q4 total revenues to be in the range of 134.2 to 137.8 million. Overall, we expect our revenue outlook to have slight impact from Invisalign ASPs resulting from rebates and product mix offset by not running the team of promotion in quarter four.
We will be running a new promotion in quarter four for Invisalign Express 5 which offers doctors $200 off the list price and is intended to drive higher trial and repeat use. Q4 revenues also reflects lower iTero scanner ASPs due to the year-end iTero scanner promotions I just mentioned.
Now let’s move onto gross margin. We expect Q4 GAAP gross margin to be in the range of 71.7 to 72.1%, and we expect non-GAAP gross margin to be in the range of 71.9 to 72.3%.
The sequential decrease in non-GAAP gross margin primarily reflect expected increases in freight cost related to international shipment and an increase in training cost as we plan to train more doctors in quarter four and to a lesser extent ASPs. In Q4 we expect GAAP operating expenses to be in the range of 73.6 million to 74.9 million.
We expect Q4 non-GAAP operating expense to be in the range of 72.6 to 73.9 million. We expect the sequential increase in non-GAAP operating expense relates to a greater number of customer events like the ADA meeting, the Greater New York Dental Show and our Ortho Summit.
Additionally, we will be increasing our investment for Asia-Pac to ensure a smooth transition back to address sales regions. We expect Q4 GAAP operating margin to be in a range of 16.9 to 17.7% and GAAP EPS to be in the range of $0.21 to $0.23 excluding any impact from potential impairment charges.
We expect Q4 non-GAAP operating margin to be in the range of 17.8 to 18.7% and non-GAAP earnings per share to be in the range of $0.21 to $0.23. In Q4 we expect GAAP to GAAP effective tax rates to be approximately 21% and the non-GAAP effective tax rate to be approximately 24%.
We expect diluted shares outstanding to be approximately 84.5 million and cash on hand to be in the range of 385 to 395 million. With that I will now turn the call back to Tom for some closing comments.
Tom Prescott
Thanks Ken. In summary, the team here at Align is as excited about the future as I have ever seen them and it's easier for me to understand why.
That’s over thousand enthusiastic customer participating in a large commercialization pilot, if you are hearing the SmartTrack is the biggest innovation in Invisalign technology ever and when combined with the G3 and G4 steps which perceive them enables treatment of far more complex cases with greater patient comfort. We are in the process of bringing our APAC distribution back in-house, gaining greater confidence and our ability to drive the business in our fastest growing geographies in the world.
Where we staging growth in Europe even in regions like the UK where austerity programs and slow-to-zero growth at the norm. We continue to do well with our scanner business in North America where our direct sales model is successfully leveraging our Invisalign resources.
In China, we continue to see strong Invisalign growth and remain bullish on its long-term potential. And around the world, we continue to gain share in the important teenager market.
We are not satisfied with recent quarter or Q4 guidance. We yet know they describe the business growing volume over 16% annually with huge head remaining for expansion.
We intend to continue on with good execution of our important strategic initiatives and have the confidence we will deliver great results for our customers and their patients, our shareholders and our committed employees. I look forward to seeing you at trade shows and investor events over the next few months as well as reporting back to you with our progress in the quarter.
And with that let’s get right to the Q&A.
Operator
(Operator Instructions) Our first question comes from the line of Matt Dolan with Roth Capital Partners. Please proceed with your question.
Matt Dolan - Roth Capital Partners
First, I just wanted to dig into what you are seeing on the growth side of the equation first, I think if we look back to I think few years ago you struggled out of the summer and there was some execution issues then, I think you may have referred to here again. Normally you guys have a lot of visibility into the upcoming quarter, so what can you tell us on a go forward basis about either stability or I think you said in your prepared remarks there is renewed interest in Q4 despite what sounds like has been a pretty slow September and October?
Tom Prescott
Well the first thing I will refer back to is the kind of this dichotomy that is existed between the channels checks, we and others have done and they are still showing strong consumer interest yet not necessarily translating into Invisalign case starts. What I say, we have seen some renewed activity now into October a bit and we believe that will start to generate.
The second thing I think if you are referring back to couple of years ago, we do expect Europe to contribute more towards growth in Q4 where we did not have that outlook say in Q4 of two years ago. So, again we think the business is healthy, we wish we had all the answers, I think there is probably few maybe broader secular trends going on in dentistry that others have called out, but what we are going to try to do is just make sure that the activity in the offices turns into case starts and that’s what we are focused on.
Matt Dolan - Roth Capital Partners
So, I guess maybe just to clarify, I think you guys did say that you felt like there is a renewed interest in Q4 even though October was slow. Again is this something maybe did the promotions that came early in Q2 pulled some revenue that you otherwise would have thought you had into earlier in the year.
What gives you that thought that things are picking up later this quarter.
Tom Prescott
We are sitting here on the 17th and as we are managing actively, we are hearing a lot of activity in the offices, patients are coming back in the offices and I will contrast that with two year ago when we still did not have what seem like positive activity even when we went to our call in October. And that in fact did not pick up until late in mid to late November or early December.
So, we see the signs f good activity. Doctors are reporting, calendars are filling up again and there are a lot of good signs.
We will watch that closely, that is reflected in our view going forward.
Matt Dolan - Roth Capital Partners
And then the second topic, I wanted to make sure we touched on was on the earning guidance side of the equation. Obviously revenues are expected to be flat, it looks like really the measure difference quarter-to-quarter here into Q4 is the gross margin.
I know you mentioned freight cost, but that it seems like international has been relatively flat or even down as a percentage of sales. So, why the 200 basis point hit their which is big part of the delta between the two periods.
Ken Arola
Freight, as we ship more and more products internationally the cost of get the product over there with the volume that we are looking at on a historical basis and the growth on the international business we are expecting that to grow nicely again this year. And given where we are, we are expecting our freight cost to be up on a sequential basis over Q3.
If you think about Q3, volumes were down in Europe as is typically are. So, when you go in sequential basis Q3 to Q4 you have a greater impact of freight for those international shipments.
Also with the shipments that are growing faster in the Asia-Pac region again that picked up additional freight cost to get product over to Asia-Pac as appose to Europe.
Operator
Our next question comes from the line of Glen Santangelo with Credit Suisse. Please proceed with your question.
Glen Santangelo - Credit Suisse
Tom. I just had one to talk to you about the weakness in the case shipment growth this quarter.
Now if you look at kind of where the weakness was, it seems like North American GPs was clearly the worst segment down the most sequentially we actually had positive growth in on the North American orthodontic community and international did somewhere in the middle. Is there something to be said here about the trend that the general practitioner in 3Q that you think can reverse itself in 4Q or do you feel like just give us some feedback on what your sales guys are telling you about what they are seeing in the market?
Tom Prescott
Let me break that into two pieces, first about maybe what happened and second about how we see it going forward. First in terms of what we saw playing out in Q3 and I think you chronicled this pretty well.
I think in the GP there was a softness, there was a slowdown, there has been reports of especially in the higher value procedures area on both LA, New York, some of the higher value procedures like full mouth restorations (inaudible) that really slowing down significantly. So, in general with GP practices even our higher volume customers which of all the groups really slowed down the most.
They tend to react more to patient traffic coming in and kind of people asking for procedures rather than initiating those conversation. So, when patients are more passive or when traffic goes down, they tend to pull back and don't compensate by initiating more they literally just pull back a bit more.
So, it's a different reaction, for the Ortho the specialist they are used to dealing with referral whether it came from own efforts or from a GP that they work with and they are used to jump in on those points of interest whether it's a first call or a patient coming in is really seriously considering.
Glen Santangelo - Credit Suisse
Tom I appreciate all of that detail and we haven’t had the chance to work on our model but just kind of looking at the guidance that you have given for 4Q, it kind of assumes that you are looking at maybe flattish case shipment growth. So, just want to be clear on what you are saying because it sounds like October started off kind of sluggish but yet in your answer to my question you just sort of said you starting to see a little bit of a pickup in activity and so in terms of case shipment growth what are you building into expectations on a sequential basis in Q4?
Tom Prescott
As Ken described well, the softness that we saw for September and into October that’s the basis of our October shipments, what shipping to patients and customers right now. And when that soft or obviously October shipments therefore revenues are little softer.
We have seen in year's where Q4 can finish very strongly, the first thing that has to happen is activity in office (inaudible). It recently is stronger than it was in September as we reported and so I think there is what we can’t get to September volume, that anchors October shipments for all practical purposes, but we do see building on that as we leave October with growing receipts in November and December.
Operator
Our next question comes from the line of Brandon Couillard with Jefferies & Company. Please proceed with your question.
Brandon Couillard - Jefferies & Company
Tom to what degree to you think coming back on the market with Ortho products may have had an impact in the third quarter in terms of the case volumes?
Tom Prescott
We actually as we look at that pretty hard we have done some survey work from a variety of sources and our data show that we are still nicely taking share from all categories of brackets, traditional, etcetera and that’s in teen and adult. So, we think if [GSE] products going back on which is a good thing, they are an important part of this industry and that was a tough deal for them.
But that’s probably coming out of the height of somebody else in the bracket and wire side does not appear to be a factor for us.
Brandon Couillard - Jefferies & Company
Have you finalized your plans in terms of how you expect to handle the U.S. medical device excise tax that goes into effect next year, and to what degree do you think you will be able to pass that onto incremental pricing or expense reductions if at all.
Tom Prescott
I’d say like every other medical device company we are working our tails off to both prepared systems and capabilities to be able to do this, even though there is no rule making in place yet at [TRF]. So, I think the simple fact is we are working on all our options and I’d say that that’s still process in place and we will talk about it much more fully when we do guidance and our view of how we are going to handle all this time next quarter.
Brandon Couillard - Jefferies & Company
Any chance you can give us the inventory balance at the end of the third quarter and then what CapEx was in the third quarter and then it looks like a much bigger number in terms of CapEx for the fourth quarter that I’d have anticipated given some of the facility relocations etcetera, winding down now here. Just where do we stand on two fronts.
Ken Arola
Inventories at the end of September were basically $15 million of which about 13 million or so of that was related to the scanner business that we have been building up some inventory here in preparation for a move in Israel which we actually just completed. So, as far as your other question on CapEx, in quarter four we have about guidance was about 12 million or so of CapEx, and that has to do with some additional equivalent or buying to put down in the facility in Juarez to handle increased capacity over time here as well as some of the outfitting of some facilities cost and stuff like that improvement point of view.
As far as CapEx this quarter, we spent I think there was about $6 million or so CapEx in Q3. And again that was mostly related to manufacturing equipment.
Operator
Our next question comes from the line of Steve Beuchaw with Morgan Stanley. Please proceed with your question.
Steve Beuchaw - Morgan Stanley
Tom, given what we are looking at now for the fourth quarter revenue, looking like it's into the single digits on an organic basis growth. Can you just walk us through the steps that get you back to the 15 to 25% growth that you are looking for over the longer term?
Your confidence is clearly not shaken here, so just walk us through the macro new features any sort of recover drivers in the business that you think you can quantify to get us to 25.
Tom Prescott
I will reinforce that I don’t feel we’re recovery mode. Certainly and that’s satisfied with our results in Q3 or the guidance we have given in Q4 the profile has been running with, but we are not in recover mode at all.
The drivers as we said before this business won’t be perfect and it won’t be perfectly linear and we have demonstrated both of those here. So, the reality is we have adoption grows, core utilization grows among say orthodontist in a non-linear way.
When we bring out new technologies that the earliest adopters that highest volume user the most technique sense of users who get a chance to get after it and then they start trying those new features on more and more kinds of cases. So, we can now really precisely deliver force systems and do it in a way that’s better for the patients and doc.
So, we expect over the next couple of years we expect that to reinforce core adoption and I’ll remind you we have given even as where we are which we have done pretty well. We are still a very small player in unit and unit share and we have tons of head room in virtually every orthodontic indication.
So, our goal is looking at a graph on our wall is making sure we grow penetration.
Steve Beuchaw - Morgan Stanley
And then just one big picture. The business it seems like year-on-year was down a couple of million on a basis on 11.5 so down 1.5.
I think the expectations are just to be a real growth market but the environment is evolving pretty quickly, you have the three maybe five new competitors on the market next year, but of course you have an advantage position being one of the bigger players in the market. Is that a business that you can get to grow double-digits next year or other extreme is something like what we have seen in this quarter and with the expectations for price to come down effectively next quarter is that more of an appropriate way to think about it.
Is this more of a driver for the aligner business. Can you help us parse out the different pieces there?
Tom Prescott
Two things, first of all we believe an have reinforced that this is a very strategic part of very early evolution, major evolution in the dental industry and being able to be at chair side, capture digital data, to be able to bring a wider set of applications to the dentist or the specialist is a very big deal and with few exceptions, for 27 years and they built a significant install base and can sell into that with upgrades. There are very few companies today that I say standalone on a scanner base have got big business.
We have got one of the biggest install bases out there but we still think we are getting started. Overtime we believe this on its own merits can be a very successful business and return to growth.
I mean it is pretty lumpy right now given uncertainty and all of those things, and even more so in Europe. But we believe that the kind of growth rates to identify data and other third parties are there to be had but we have taken a longer term view of this business.
The second part of that is you asked about Invisalign, I’m not going to quote the numbers here but we continue to see a substantial amount of our incoming cases now done by scans, at the meaningful number and growing very nicely every single quarter. I’d just say friction goes down for everybody involved, the patient, the doctor in a practice and Align in so many ways is faster, better, cheaper, easier, more precise.
Aligner seem to fit better, the whole cycle of case to shipment is faster, and that’s the trend it's continuing. The second thing is the doctors that use, take all the Orthos that have put scanners in, there is a meaningful number of increased cases, they are doing more than every other cohort around them, whether they were of small low volume and medium volume or a high volume Ortho.
On average they are doing a significantly greater number of cases on a quarterly or annual basis and that’s just again from reducing (inaudible). We are in the early stages of it, but there is a lot of positive signs and we are in this for the long-term.
Operator
Our next question comes from the line of Jeremy Feffer with Cantor Fitzgerald. Please proceed with your question.
Jeremy Feffer - Cantor Fitzgerald
I just wanted to come back to pricing very quickly. This is once again we saw average revenue per case down.
I know lot of its tied to promotional activities, volume rebates. Where does this trend go as we look into next year?
Obviously the promotions with this quarter, (inaudible) obviously done a great job in driving volume growth. Is there a point where you are worried about slowing down the promotional activities and seeing a slowdown in volume growth or how do you think about overall pricing going into the next year or so.
Ken Arola
I’d just start out by saying pricing has been very stable for us over the past number of years. We haven’t changed prices for a number of year's now on our products and we have chosen to do is at various points in time pointed promotions.
So, over the long-term we think it's a good opportunity to be a growth driver in the business. We are run our advantage program for the doctors on the consistent basis on a year-over-year, we see doctors continuing to move up overtime in the number of cases that they are doing.
Some quarters they move faster than other, this last quarter the biggest impact ASPs from a promotional point of view is certainly the teams of various promotion on a sequential basis and the other piece that you didn’t mention was really the foreign exchange rates that they moved pretty quickly from Q2 to Q3. Our view is that we will continue to look at promotions at appropriate times in the year for the business on the Invisalign as well as the iTero side of the business for example the 4,000 off promotion running in quarter four that will stimulate more placements of scanners in the marketplace.
Jeremy Feffer - Cantor Fitzgerald
And on the competitive side, are you guys seeing any pickup inactivity from any of the newer entrance in the clear aligner space?
Tom Prescott
No, not really, I mean we watched this very, very carefully and I think if there is a little, so we are more than holding share for the other small players that are out there in clear aligner and Ortho. In GP, we may have had a little leakage we think call it that against Clear Correct we think, frankly Q1 and Q2 especially among lower volume GPs.
And we think most of that was price driven maybe through group on and stuff like that. But we don't see any kind of longer term trends and we have not seen a kind of traction among consistent users from any other player.
We see trial from time to time and then based with the features they don't have and can’t get and the capability that other players don't have the trend to revert back to Invisalign. So, that’s been the pattern where obviously trying to find the balance being confident and paranoid.
Operator
Our next question comes from the line of John Kreger with William Blair. Please proceed with your question.
John Kreger - William Blair
Tom, we can just think about the growth that you have seen in recent months from a little bit different perspective. We certainly compare that it's been a tough environment in dental but, I think we also would have said that was probably the case a year ago or few quarters ago.
So, if you think about what do you think is really going on from a broader perspective? Do you think there is less orthodontic starts going on across the market or maybe less uptick by orthodontist as the excitement on G3 and G4 as perhaps faded a bit.
What is the bigger picture on market share?
Tom Prescott
So, first of all we had a very strong first half and we had a very strong Q1, and carried a lot of that into Q2 with AOO and all of that. So, I don't know if it was more patient driven or practice driven, I don't know and we struggled to find primary data in this area that’s useful.
So, what we are left with is the data we can get from third parties our own several times a quarter bottoms up and top down views our own qualitative and quantitative research with groups of customers and it's a pretty mixed bag, but for whatever set of reasons in the summer the late summer and into September, it was just like the offices were less engaged and there was less traffic.
John Kreger - William Blair
So, just a quick follow-up from our perspective G3 and G4 were very well received in the market. As you think about SmartTrack since this is new to us what do you think the significant is the SmartTrack relative to G3 and G4 more or less impactful?
Tom Prescott
We have our own views and we always have a set of metrics, we applied to any new major project innovation, product innovation and we track whether quarter-over-quarter, year-over-year how we are doing against whether it's case complexity we are measuring, getting more class two cases whether we are looking at that sort of adoptions within certain practices. So, we haven’t started those things, setup and we will see how it does, but one of the very clear points of feedback since May, for example when we did the earlier pilots the doctors that we are treating patients said I don't want to go back to old material please let me keep this.
And then some of them were involved in the commercialization pilot in May.
John Kreger - William Blair
And then one last one, if you think about the guidance you have given us for Q4, does that guidance assume a better lift in volumes in the second half of the quarter late October into November and December. Are you assuming more of a steady state with what you are seeing so far early days in the quarter?
Ken Arola
John, we actually don't really comment on inter-quarter trend that we are looking that so what we are trying to point out in the call is that we saw the softness in September and into early October here, but on the contrary we are seeing activity in doctors office that’s still being pretty active, our sales force again is still active with the doctor based in, so our view is that as Tom said with activity picking up to help us as we go forward here.
Shirley Stacy
Thank you every one for joining us today. Well this concludes our conference call.
We look forward to seeing you at coming financial conferences in industry meetings. If you have any questions please contact Investor Relations.
Thanks and have a great day.
Operator
Thank you. This concludes today’s teleconference.
You may disconnect your lines at this time and thank you for your participation.